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FinCEN Amps Up Virtual Currency Regulation and Warns About Misuse of VC by EVAN DAVIS

The government continues to show its presence regulating virtual currency and enforcing civil and criminal laws in this developing area. Our Firm has had a number of clients involved in civil tax and criminal (tax, securities, and Bank Secrecy Act (“BSA”)) investigations, and the Government continues to show its active presence. FinCEN (Financial Crimes Enforcement Network, which is an arm of the Treasury Department that collects and analyzes financial transactions to look for terrorist financing and illegal activity such as money laundering) on May 9, 2019 issued a one-two punch to the virtual currency industry. First, it reminded persons and businesses that the BSA applies to virtual currency and, if they are “money service businesses” (MSBs) under the BSA, then they have to comply with the BSA’s rules and regulations. FinCEN Guidance. Second, it warned financial institutions to be on the lookout for criminal activity being conducted through virtual currency transactions. FinCEN Advisory.

The message of the two notices: FinCEN has virtual currency on its radar; it knows that there’s a high level of noncompliance with the BSA; and the next step is enforcement of the BSA through civil and criminal cases.

The Guidance

In its Guidance, FinCEN acknowledged that statements about BSA’s applicability to virtual currency have been scattered, yielding confusion. An optimist would view the new guidance as FinCEN’s effort to help MSBs navigate the complex regulatory scheme applicable to virtual currency. A pessimist would view this as creating Exhibit Number One against future defendants in BSA criminal cases, admitted to prove the defendant knew and understood his BSA obligations because they were posted on the Internet.

The rules only apply to MSBs that qualify under the BSA, but you might be surprised how broad the definition of MSBs is. It includes any person or business not otherwise regulated (by the SEC, CFTC, Comptroller of the Currency, etc.) that routinely receives and then transmits currency or “other value that substitutes for currency . . . by any means.” Persons who dabble in buying and selling virtual currency in exchange for fiat currency or even for other virtual currency could stray over the line without knowing it, as there is no specific dollar-volume demarcation between MSBs and non-MSBs. The test focuses exclusively on conduct, without regard to whether the money transmission is incidental to a business, for example.

The guidance notes that persons who do peer-to-peer virtual currency exchanges have to register, as well as persons running virtual-currency kiosks. I’ve had clients in both categories and have seen that individuals frequently are unaware entirely of the BSA. The guidance becomes uncertain in discussing initial coin offerings, which the SEC and CFTC claim to regulate. Even reselling digital tokens can qualify as MSB activity under certain circumstances.

Being subject to the BSA can be a headache. Obligations include developing, implementing, and maintaining an effective, written anti-money laundering program (“AML program”). Good for lawyers who do AML programs, but it could be an expensive and time-consuming surprise for individuals and small businesses who unwittingly became MSBs. The real takeaway is to avoid unwittingly straying over the line of an MSB.

The Advisory

The second, and more-worrying, document is the Advisory on Illicit Activity Involving Convertible Virtual Currency. In it, FinCEN identified “prominent typologies and red flags associated with [criminal] activity and identifies information that would be most valuable to law enforcement, regulators, and other national security agencies in the filing of suspicious activity reports (SARs).”

Many of the red flags are obvious – virtual currency transactions to conduct illegal transactions on the darknet (AlphaBay, etc.) and using nominees to conduct peer-to-peer transactions – but others might not be as obvious. One category is unregistered foreign MSBs – MSBs located overseas that do business “wholly or in substantial part” in the United States but are not registered as an MSB. The largest example given was an indictment in the Northern District of California of Alexander Vinnik for having operated “BTC-e” without registering it as an MSB and without complying with anti-money-laundering rules, etc. FinCEN imposed fines of $122 million in addition to what was charged in the indictment. The Advisory also discusses virtual currency kiosks (similar to ATMs), some of which apparently are unregistered.

Most troubling for users of virtual currency is that certain red flags are simply steps used to increase anonymity or security. FinCEN believes that the use of a virtual private network (VPN), which is a standard security measure, is a red flag. Even being older than the average user is a red flag. Two unwanted results can flow from a red flag: first, the virtual currency exchanger could be subject to additional scrutiny by law enforcement, including the IRS; and, second, the government may assume criminal intent if the exchanger has other issues, such as major errors on tax returns or similar issues for which the government is attempting to determine the exchanger’s state of mind.

As important as knowing your customer is for an MSB, the major takeaway from this Advisory is that users of virtual currency should know as much as possible about the MSBs with whom they transact. Even if the users aren’t obligated to comply with the BSA, if they transact with an unregistered MSB, then they could be inviting the government to look at them under a microscope. Few people look good under a microscope.

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3288. Mr. Davis is a principal at Hochman Salkin Toscher Perez, P.C. He spent 11 years as an AUSA of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) where he handed civil and criminal tax cases, and of the Major Frauds Section of the Criminal Division where he handled white-collar, tax, and other fraud cases through jury trial and appeal. As an AUSA, he served as the Bankruptcy Fraud coordinator, Financial Institution Fraud coordinator, and Securities Fraud coordinator, and the U.S. Attorney General awarded him the Distinguished Service Award for his work on the $16 Billion RMBS settlement with Bank of America. Before becoming an AUSA, Mr. Davis was a civil trial attorney in the Department of Justice’s Tax Division in Washington, D.C. for nearly 8 years.

Mr. Davis represents individuals and closely held entities in criminal tax investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, and federal and state white-collar criminal investigations including money laundering and health care fraud. He is significantly involved in the representation of taxpayers throughout the world in matters involving the ongoing, extensive efforts of the U.S. government to identify undeclared interests in foreign financial accounts and assets and the coordination of effective and efficient voluntary disclosures (Streamlined Procedures and otherwise).